Net Lease Breaks Tradition with the Typical CRE Summer Slowdown

Summertime generally means hot weather and time off. For commercial real estate, summertime can also mean transactional slowdowns. While technology helps move contracts and closings along, the consensus is that buying and selling becomes a trickle between Memorial Day and Labor Day.

Early indications show that 2018 is holding true to form, except in net lease. The slower than normal pace this year for the wider commercial real estate industry is more likely due more to cycle than season. While overall industry has slowed, net lease has stayed strong. Net lease transaction volumes have remained steady, in direct opposition of the broader commercial real estate market.

Yes, It’s the Cycle

Commercial real estate transactions over the past several years broke a lot of records, but, no more. On the financing side, a recent report in American Banker noted that banks and other traditional lending institutions are pulling back from CRE loan originations, partly because of “broader economic forces,” such as an increase in shared workspaces (leading to less leasing demand for office space) and an increase in loan delinquencies. The Mortgage Bankers Association pointed out that headwinds such as interest rate increases and net operating income decreases are also putting pressure on financial activities.

Another report on the slowdown by Real Capital Analytics, noted U.S. commercial real estate transaction volumes in the first half of 2018 had a slight uptick over the year before. Much of the activity this year consists of portfolio and entity level deals. Something else to note: retail property sales are trending downward.

None of this suggests investors are turning their backs on commercial real estate investments. What it does suggest is that the record-breaking activity from the past several years is unsustainable, and the cycle is winding down to more realistic levels.

Active Net Lease Investments

Overall, retail investments have declined, but this is not the case for net-lease properties. Dollar store and quick-service restaurant (QSR) trades have stayed strong, thanks to solid fundamentals.

In many cases, Dollar Generals, Family Dollars or Dollar Trees are located in secondary and tertiary markets, where they are the only consumer-goods game in town. Investors typically receive a higher yield from these properties, which explains why we are seeing more activity in this sector. On the QSR side, the use of technology and creative menus catering to a changing demographic has led to the continued success and high demand. Both, dollar stores and QSRs are e-commerce-resistant and offer long-term leases.

Net-lease properties are subject to seasonal and cyclical slowdowns as well as regional or industry trends. In some highly demanded markets, such as Florida or California, there is more competition for such assets, driving up prices and compressing cap rates. Some properties will see the impacts of industry changes in their pricing and demand, such as currently uncertain long term future of Rite Aid. The Rite Aid – Albertson’s merger has not been approved yet and Rite Aid properties have been trading at a discount to the other pharmacies because of this uncertainty.

For the time being, the summer slowdown – or even the cyclical pullback – isn’t having as great an impact on the net-lease sector as it is on the overall commercial real estate industry.

The views expressed here are the author’s own and not that of ALM’s Real Estate Media Group.